Interesting ethanol factoid from the WSJ

I was reading a story in the Wall Street Journal titled “Why Gasoline Prices May Rise,” and the following paragraph grabbed my attention:

Another reason for steady gasoline prices: the use of ethanol as an additive to gasoline is on the rise. While crude prices have soared, ethanol prices have dropped as much as 30% in recent months and are likely to drop more, Eitan Bernstein, an analyst with Friedman, Billings, Ramsey & Co., said in a report yesterday. Ethanol costs more than 60 cents a gallon less than gasoline, and gasoline suppliers can offset some of the rise in crude-oil prices by blending their gasoline with small amounts of the cheaper fuel.

Would be curious to find out how much of that affordability of ethanol is due to government incentives (mind you, it’s not like the oil industry doesn’t receive its own subsidies). In any event, claims that ethanol will contribute to higher gasoline prices are being proven wrong. The next step is to show that cellulosic ethanol can follow the same cost curve.

Ethanol benefits from a $0.51 per gallon tax credit at the federal level (plus another $0.10 per gallon if you are a small producer), plus subsidies or fuel-tax concessions at the state level that in some states (e.g., Kentucky) add as much as $1.00 per gallon in income for producers.

You then say, “(mind you, it’s not like the oil industry doesn’t receive its own subsidies)”

They do, but most analyses of those estimate the value of their subsidies is more in the neighborhood of 3% to 10% of the market value, not 50% (or even 100% in a few states) of the market value for ethanol. If ethanol is to become a significant component of the USA’s gasoline pool, such rates of subsidization cannot be sustained.

And “In any event, claims that ethanol will contribute to higher gasoline prices are being proven wrong.”

The current slump in the price of ethanol is due to a boom and bust cycle in the industry: there was a surge in construction of new facilities, starting in 2005, and these new plants are now starting to produce. The laws of short-term supply and demand naturally mean that prices will soften.

Over the long run, however, what matters is the fundamentals, especially the price of feedstock, and that is likely to remain high, especially if the industry continues to expand. The fact that some biomass can be produced relatively cheaply (e.g., for some future cellulosic-ethanol manufacturing plants) is neither here nor there: what matters is the return required for owners of the land, and whether there are other claims on that biomass — as for electric power generation. There is a lot of hype surrounding ethanol of all stripes. What we need is more realism in this debate, not blinkered optimism.

Also don’t forget to adjust your price differentials for differences in energy density between ethanol and gasoline. Normally, one would expect there to be at least a 30% discount in the price of ethanol (compared with the price of unleaded gasoline) for it to compete on an energy basis.

My comments above refer to the situation in the United States (since that is what the WSJ article was referring to). The situation in Canada is somewhat different in terms of the role of government incentives. They are high for producers in some provinces (when combined with Federal incentives), but at least the Federal Government and some of the provinces have designed their incentives to shrink if oil prices rise — in contrast with the United States, where no such adjustments are built into the incentives on offer.